Five fund picks for income investors

3rd March 2015

As the tax-year draws to a close and investors look to take advantage of their remaining Isa allowances before it is too late, Tom Stevenson, investment director at Fidelity Personal Investing, gives his five fund picks for income…

This week the Bank of England’s monetary policy committee will almost certainly leave interest rates unchanged at 0.5%. They have been pegged at this level for six years now, dishing out an ongoing headache to anyone seeking to achieve a decent income from their savings and investments.

This is a particular problem for anyone looking to take advantage of the Government’s new pension freedoms from next month. It is all well and good being allowed to remain invested after retirement and to take an income from your investments but only if you can find a sustainable source of that income.

Unfortunately the Bank of England looks to be in no hurry to return UK interest rates to what we used to consider a normal level. Rates look like staying lower for longer.

In a persistently low-return environment, where is the best source of a sustainable income?

1. Fidelity Enhanced Income Fund: The first fund on my list is an equity income fund with added oomph. The Fidelity Enhanced Income Fund is managed by Michael Clark, who also runs the Fidelity Moneybuilder Dividend Fund. In fact the Enhanced Income Fund is a super-charged version of that plain-vanilla dividend fund. The Enhanced Income Fund generates a higher income than the ordinary equity income version of the fund is by selling to other investors the right to buy shares owned by the fund at a slightly higher price than they would have to pay in the market today. It receives an upfront payment, or premium, in exchange for that right (known as a covered call option) and the premium is passed on to investors in the form of a higher dividend.

2. Woodford Equity Income Fund: The second fund will be familiar to many investors. The Woodford Equity Income Fundwas launched last year, the first in an expected series of funds from Neil Woodford’s new business, Woodford Investment Management. It is early days yet to see how the fund will perform in the long run but Neil Woodford has an extended record of success and I was impressed by his down-to-earth approach when he came in to record an interview at the time of the fund’s launch.

3. Henderson Preference and Bond Fund: Income investors need not restrict themselves to equity income funds, of course. A well-balanced portfolio is likely to have a mixture of different assets, including fixed income. The Henderson Preference and Bond Fund’s name is actually something of a historical anomaly. In fact it is simply an all-terrain bond fund that would these days probably be called a Strategic Bond fund (it was launched nearly 40 years ago). The primary aim of the fund is to generate an income – it pays a quarterly dividend, which goes some way to explaining why the average age of the fund’s investors is in the mid-70s.

4. Invesco Perpetual European Equity Income Fund: The UK has long been a good source of equity income because shareholders have encouraged companies to pay out surplus funds in the form of dividends. But that income culture is spreading and income-paying shares are available throughout the world today. In particular, Europe has many high-quality companies paying sustainable income streams and these are the focus of the Invesco Perpetual European Equity Income Fundrun by Stephanie Butcher. She believes that high cash balances will start to get used by companies, not just for capital spending and acquisitions but also for dividends and buybacks. She is attracted by the relatively high number of companies with dividend yields surpassing the income on their own corporate bonds.

5. Henderson UK Equity Income and Growth Fund: My final income fund is also a bit out of the equity income mainstream. The Henderson UK Equity Income and Growth Fund, as its name suggests, has a focus on both income and capital growth. James Henderson, its manager, believes that if you grow the capital of a fund, the income will follow. As a consequence, he has more of a focus on smaller and mid-cap companies than a traditional blue-chip equity income fund.